Slouching Towards Utopia?: The Economic History of the Twentieth
Century

-XX. The Great Keynesian Boom: "Thirty Glorious Years"-

J. Bradford DeLongUniversity of California at Berkeley and NBER

February 1997

European Supergrowth

The Moderation of the Business Cycle

Labor Peace

Bretton Woods

Technological Diffusion

European Supergrowth

Even a casual glance at numbers and growth rates reveals
that growth and recovery after World War II was astonishingly rapid. Considering
the three largest Western European economies-Britain, France, and Germany-the
Second World War infiicted much more damage and destruction on a much
wider area than the First. And (except for France) manpower losses were
greater in World War II as well. The war ended with 24 percent of Germans
born in 1924 dead or missing, and 31 percent disabled; post-war Germany
contained 26 percent more women than men. In 1946, the year after the end
of World War II, GNP per capita in the three largest Western European economies
had fallen by a quarter relative to its pre-war, 1938 level. This was half
again as much as production per capita in 1919 had fallen below its pre-war,
1913 level.

Yet the pace of post-World War II recovery soon surpassed
that seen after World War I. By 1949 average GNP per capita in the three
large countries had recovered to within a hair of its pre-war level, and
in comparative terms recovery was two years ahead of its post-World War
I pace. By 1951, six years after the war, GNP per capita was more than
ten percent above its pre-war level, a degree of recovery that post-World
War I Europe did not reach in the eleven post-World War I years before
the Great Depression began. What post-World War II Europe accomplished
in six years had taken post-World War I Europe sixteen.

The restoration of financial stability and the free play
of market forces launched the European economy onto a two-decaDeLong path
of unprecedented rapid growth. European economic growth between 1953 and
1973 was twice as fast as for any comparable period before or since. The
growth rate of GDP was 2 percent per annum between 1870 and 1913 and 2.5
percent per annum between 1922 and 1937. In contrast, growth accelerated
to an astonishing 4.8 percent per year between 1953 and 1973, before slowing
to half that rate from 1973 to 1979.

Moreover, the post-World War II recovery did more than
just rapidly restore Western Europe to its previous peacetime long-run
growth path. French and German growth during the long-post World War II
boom carried total production per capita to levels that far outstripped
their economies' pre-1929 or even pre-1913 growth trends. In both France
and West Germany labor productivity had outstripped their pre-1913 trends
by 1955, and thereafter saw no noticeable slackening of growth. The dynamic
of western European growth after World War II is an order of magnitude
stronger than had hitherto been seen.

Consider, as an example, the west German economy. In the 1950s it certainly
boomed. Recovery in the 1940s can be understood as recovering the productive
capacity that had existed before the war, with the added benefit of an
extra decade and a half's worth of technology. But the German economy in
the 1950s crashed through the output-per-capita levels that would have
been projected by someone connecting pre-World War II peaks, and has come
to rest since 1973 at about its pre-1913 growth rate, at a level of output-per-capita
some forty percent higher than anyone would have dared to project on the
basis of the pre-World War II experience.

The magnitude of the boom came as a surprise to the Germans.
The real value of a basket of German stocks multiplied eightfold during
the 1950s--without any reinvestment of dividends--for an average real return
of twenty-five percent per year.

In addition the German economy showed itself able to absorb
a very large population displaced from the east in a relatively small number
of years. Unemployment in 1950 was ten percent. By 1960 it was down to
one percent of the labor force.

This reduction of unemployment from double-digit levels to zero-digit levels
took place with no sign of inflation or excess demand pressure at all:
the average inflation rate from 1949 to 1970 was 1.7 percent per year.
And this reduction of unemployment did not trigger anything like the degree
of labor strife that had characterized pre-World War II (and pre-World
War I) Germany.

The Moderation of the Business Cycle

Europe's rapid growth in the 1950's and 1960's was associated
with exceptionally high investment rates. The investment share of GNP was
nearly twice as high as it had been in the last decade before World War
II or was again to be after 1972. Accompanying high rates of investment
was rapid growth of productivity. Even in Britain, the laggard, productivity
growth rose sharply between 1924-37 and 1951- 73, from 1 to 2.4 percent
per annum. This high investment share did not, however, reflect unusual
investment behavior during expansion phases of the business cycle. Rather,
it reflected the tendency of investment to collapse during cyclical contractions
and the absence of significant cyclical downturns between 1950 and 1971.

Post-World War II economic policy was surely far better
than what had been seen in the Depression, and somewhat better than what
had been seen in the pre-Depression era. On average, year in and year out,
the economy's production was perhaps one or two percentage points closer
to its full employment level than in the pre-Depression period. This is
not a small number in absolute terms: it is $75 billion a year at present
rates, or $300 a year per capita. But it outweighs the costs imposed by
the tolerance of infiation only as long as the Federal Reserve is
able to keep infiation moderate through its games of bluff and recession.
And it is small relative to the benefits of faster long-run economic
growth-which was the truly important and impressive feature of the post-World
War II Great Keynesian Boom.

The political and economic environment within the industrial
nations was extraordinarily favorable in the years immediately after World
War II. All parties and economists were terrified lest the Great Depression
return. To fight off this possibility, politicians and economists
paid very close attention to the lessons of the Great Depression and of
the New Deal, which were seen as roughly three: unemployment is the disease,
high demand is the medicine, and the federal government-though loose monetary
policy and deficit spending-is the doctor. Confidence in the
mixed economy commitment to maintain spending, demand, and production helped,
perhaps more than the commitment itself, to keep the post-WWII era free
of Great Depressions. Instead, the mixed economies risked an acceleration
in infiation, rather than even a small chance of a severe Depression.
Over time, this pro-infiation bias intensified, became anticipated,
and so lost some of its efficacy at preventing unemployment.

As time passed, and the memory of the Great Depression
dimmed, governments' commitments to fight unemployment fiercely
even at the cost of risking some infiation began to fiag. This
became of great importance because the post-World War II economic system's
ability to deliver low unemployment without high infiation began to
erode as well. Between 1954 and 1969-between the Korean War and the height
of the Vietnam War-it looked as though the U.S. economy was sliding back
and forth along a stable infiation-unemployment "Phillips Curve."
Democratic governments tended to spend more time at the left end of the
curve, with relatively high infiation and relatively low unemployment.
Republican governments tended to spend more time at the right end, with
low infiation and higher unemployment. But by absolute and by historical
standards, both infiation and unemployment were low.

Labor Peace

Some of Europe's cyclical stability was due to the advent
of Keynesian stabilization policy. But Keynesian policy was effective only
so long as labor markets were accomodating. So long as increased pressure
of demand applied by governments in response to slowdowns produced additional
output and employment rather than higher wages and hence higher prices,
the macroeconomy was stable. Investment was maintained at high levels,
and rapid growth persisted.

The key to Europe's rapid growth, from this perspective,
was its relatively inflation-resistant labor markets. So long as they accomodated
demand pressure by supplying more labor input rather than demanding higher
wages, the other pieces of the puzzle fell into place. What then accounted
for the accomodating nature of postwar labo markets?

The conventional explanation, following Kindleberger (1967),
is elastic supplies of underemployed labor from rural sectors within the
advanced countries and from Europe's southern and eastern fringe. Elastic
supplies of labor disciplined potentially militant labor unions. Another
explanation is "History." Memory of high unemployment and strife
between the wars served to moderate labor-market conflict. Conservatives
could recall that attempts to roll back interwar welfare states had led
to polarization, destabilizing representative institutions and setting
the stage for fascism. Left-wingers could recall the other side of the
same story. Both could reflect on the stagnation of the interwar period
and blame it on political deadlock.

Yet another potential explanation is the Bretton Woods
System. Bretton Woods linked the dollar to gold at $35 an ounce and other
currencies to the dollar. So long as American policy makers' commitment
to the Bretton Woods parity remained firm, limits were placed on the extent
of inflationary policies. So long as European policy makers were loath
to devalue against the dollar, limits were placed on their policies as
well. Price expectations were stabilized. Inflation, where it surfaced,
was more likely to be regarded as transitory. Consequently, increased pressure
of demand was less likely to translate into higher prices instead of higher
output, higher employment, and greater macroeconomic stability.

A final potential explanation is the legacy of the Marshall
Plan. Putting the point in this way serves to underscore that the Marshall
Plan was but one of several factors contributing to observed outcomes.
In principle, the Marshall Plan could have mattered directly. Marshall
Planners sought a labor movement interested in raising productivity rather
than in redistributing income from rich to poor. With labor peace a potential
precondition for substantial Marshall Plan aid, labor organizations agreed
to push for productivity improvements first and defer redistributions to
later.

Moreover, money was channeled to non-Communist labor organizations.
European labor movements split over the question of whether Marshall aid
should be welcomed--which left the Communists on the wrong side, opposed
to economic recovery.

Bretton Woods

International monetary disorder--financial crises, devaluations,
hyperinflations, trade restrictions for balance-of-payments reasons--had
been a principal obstacle to recovery after World War I. The international
monetary system has relatively little role in the history-of-events of
the generation after World War II because not much went wrong: another
example of the principle that "happy is the land that has no history."

When the delegations--the American delegation headed by
Treasury Assistant Secretary Harry Dexter White, the British delegation
headed by John Maynard Keynes, and the other delegations--met in the somewhat
faded mountain resort of Bretton Woods, New Hampshire to build a post-WWII
international monetary system, their minds were focused on what they saw
as the lessons of the interwar period. Thus the Bretton Woods system that
they build departed from the gold exchange standard in three interlinked
ways:

Exchange rates were fixed and pegged, but the pegs were
adjustable in response to "fundamental disequilibrium." The idea
was to avoid a situation like that of Britain in the late 1920s, when either
devaluation or deflation is called for, and adherence to the rules of the
game of the gold standard would force deflation and a prolonged depression.

Controls on international capital flows were explicitly
allowed: Keynes and White had no desire to see international speculators
move exchange rates and upset governments' policies.

The International Monetary Fund was established to be
a referee. It would extend financial support to countries that needed more
reserves to ride out a temporary balance-of-payments deficit. It would
be the judge of whether "fundamental disequilibrium" existed
and thus of whether exchange rate pegs should be changed.

The Bretton Woods conference of 1944 set up the post-World
War II international economic system which was to prove extraorinarily
successful. In intention, obedience to the rules of the International Mondetary
Fund would provide macroeconomic equilibrium. Countries would maintain
fixed exchange rate parities vis-a-vis one another. When one country
ran a persistent balance of payments deficit that threatened to exhaust
its reserves, it could borrow from the IMF. In return, the IMF would seek
macroeconomic policy adjustments in order to bring the balance of payments
back to a sustainable level, or, in the case of "fundamental disequilibrium,"
would recommend a devaluation.

The existence of the Bretton Woods framework made it much
easier to achieve and maintain a régime of low tariffs and free
trade. With stable exchange rates, a chief weapon that domestic industries
could pressure governments to use to protect them (and a chief excuse for
protection) would not be in operation. And to the extent that the IMF's
rules helped keep employment high and Great Depressions at bay, there would
be little pressure for protectionism. Absent macroeconomic collapse, it
would be hard to make a case that protecting countries would gain more
than-as they cut themselves off from the international division of labor-they
stood to lose.

A second institution, itself not the creation of Bretton
Woods but a stopgap that grew up when the institution envisioned at Bretton
Woods, the International Trade Organization, failed to be born, was the
General Agreement on Tariffs and Trade. It established general rules-multilateralism
and non-discrimination-that meant that trade liberalisation for one would
become trade liberalisation for all, and established, for the first
time, an ongoing institution dedicated to the reduction of barriers
to trade throughout the world. The Bretton Woods framework, and GATT, were
successful. The average tariff imposed by the United States declined by
nearly 92 percent over the 33 years from the Geneva Round of 1947 to the
Tokyo Round of 1974­79. From 1953 to 1973, world real GNP grew at an
average rate of 4.7 percent, and world trade at a rate of 7.5 percent per
year.

Did trade liberalization cause the trade expansion? To
a large degree, yes. Did the trade expansion drive the economic prosperity
of the long Keynesian boom? It seems likely that, to some degree, it did.
Intra-industry trade became very important in the post-World War II era.
World trade became not the exchange of coffee for washing machines, but
the exchange of small cars for large cars, or of high-priced silks for
moderate-priced synthetics. The post-World War II industrial world was
populated by a large number of firms making differentiated products,
and then selling these products worldwide. The added scope of the market
allowed for a greater division of labor, and here-in consumers' choice
certainly, and in productivity possibly-was a major gain from trade. Moreover,
many World Bank and other studies have documented a strong link between
trade liberalization and economic performance in the developing world.
There is no reason to think that such a link does not exist for the industrial
west as well.

Technological Diffusion:

As industries in the industrial core became more and more
mechanized-more and more characterized by "mass production"-they
should have become more and more vulnerable to foreign competition from
other, lower wage countries. If Ford can redesign production so that unskilled
assembly line workers do what skilled craftsmen used to do, why can't Ford
also-or someone else-redesign production so that it can be carried out
by low wage Peruvians or Poles or Kenyans rather than by Americans, who
are extraordinarily expensive labor by world standards?

Industries do migrate from the rich industrial core to
the poor periphery, but they do so surprisingly slowly. One reason is added
risk-political risk of all kinds tends to make investors wary of committing
their money in places where it is easy to imagine political disruptions
from the left or the right. Moreover, there are substantial advantages
for a firm in keeping production in the industrial core, near to other
machines and near other factories making similar products. It is much easier
to keep the machines running. A reliable electric power grid is much more
likely to be found in the industrial core. And so are the services of specialists
needed to fix the many things that can go wrong-minimum efficient
scale for an industrial civilization can be far larger than the apparent
minimum efficient scale for a plant.

These factors are an order of magnitude more important
for industries that are in technological fiux than for those that
have a settled, relatively unchanging technology. A principal advantage
of locating near the firms that make your machines comes from the
interchange and feedback of users and producers-feedback that is valuable
only if designs are still evolving. And the principal advantage of a machine-knowing
and relatively well-educated labor force is the ability to adapt to using
slightly different machines in somewhat different ways-once again, valuable
only if small changes are constantly being made. As industries reach technological
maturity, freeze their production processes into set patterns, and become
businesses in which sales are made on the basis of the lowest price, they
tend to migrate to the periphery of the world economy: handed down to poorer
countries as, in the words of a Japanese development advisor, older siblings
hand down to younger ones clothes they no longer need.

Thus the maintenance of American industrial preeminence
throughout the twentieth century depended on the constant introduction
of new products and processes that did require immediate feedback, and
that could not be easily copied or reproduced outside the United States.
This requires that the United States continue to be the locus of invention
and innovation. The process of technological change does not make leaps.
Continuity of development and the importance of hands-on experience are
crucial. In this context, "continuity" means that most innovation
and productivity growth is the result not of single, discrete, major inventions
or borrowings but rather of a continuous and ongoing process of improvement
and adaptation, no one step in which is particularly important or noteworthy.
In this context, "experience" means that the skills needed to
handle and productively use modern technology are most easily and rapidly
gained by using modern technology.

As Nathan Rosenberg puts it: "most inventions are
relatively crude and inefficient [at first].They are, of necessity,
badly adapted to many of the ultimate uses to which they will eventually
be putthey offer only small advantages, or perhaps none at all." Consider
that, that over the forty years from 1870 to 1910, the lion's share of
cost reduction in American railroads was contributed by incremental changes
in the design of freight cars and locomotives. One by one, these changes
were small and barely noticed: most of them have origins that are unknown
today. But over forty years they added up to a doubling of the effective
power of locomotives and to a tripling of the capacity of freight cars.
There is a similar pattern in the CAT scanner industry: only the explosion
of incremental improvements and developments in the decade after invention
made the CAT scanner a useful device rather than an intriguing toy.

How are incremental improvements made? Clearly they are
made by those who are already very familiar with the technology and its
uses. Without workers and managers with hands-on experience, the process
of technology transfer and technological adaptation becomes impossibly
difficult. The principle that hands-on experience is the best, and
perhaps the only, way to develop expertise at the technologies of the industrial
revolution, and indeed to develop the technologies themselves, is not limited
to technologies narrowly embodied in machines. It applies to the "technologies"
of modern business organization as well, to the Ford Motor Company's attempt
to transplant mass production to Great Britain in the period during and
after World War I as well as to the attempts of Japanese producers to transplant
what is called "lean production" back to the United States in
the 1980's.

It is worth noting that mass production had similar difficulties
diffusing throughout the United States in the beginning. Only one firm-General
Motors-could even come close to matching Ford's productivity levels in
the 1920's and the 1930's, and General Motors found its transition to mass
production eased by its ability to hire the production management team
that had invented mass production at Highland Park as its individual members,
one after the other, fell out of favor with Henry Ford.